Note 18 – Related Party Transactions
During the third quarter of 2019, Carl C. Icahn and his affiliates (shareholders) increased their ownership interest in the Company. In the normal course of business, the Company provides services to, and purchases from, certain related parties with the same shareholders. The services provided to these entities included those related to human resources, end-user support and other services and solutions. The purchases from these entities included office equipment and related services and supplies. Revenue and purchases from these entities were included in Revenue and Costs of services / Selling, General and administrative, respectively, on the Company's Condensed Consolidated Statements of Income (Loss).
Transactions with related parties were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended September 30, | | | | Nine Months Ended September 30, | | |
(in millions) | | 2019 | | 2018 | | 2019 | | 2018 |
Revenue from related parties | | $ | 7 | | | $ | 10 | | | $ | 25 | | | $ | 32 | |
Purchases from related parties | | $ | 6 | | | $ | 6 | | | $ | 18 | | | $ | 23 | |
The Company's receivable and payable balances with related party entities were not material as of September 30, 2019 and December 31, 2018.
ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management’s Discussion and Analysis (MD&A) is intended to help the reader understand the results of operations and financial condition of Conduent Incorporated and its consolidated subsidiaries. MD&A is provided as a supplement to, and should be read in conjunction with, our Condensed Consolidated Financial Statements and the accompanying Notes.
Overview
We are a global enterprise and leading provider of digital business services withmission-critical services and solutions on behalf of businesses and governments – creating exceptional outcomes for its clients and the millions of people who count on them. Through people, process expertise in transaction-intensive processing, and technology such as analytics and automation. Our portfolio covers both front officeautomation, Conduent solutions and back office operations; however, theservices create value by improving efficiencies, reducing costs and enabling revenue growth. A majority of our revenueFortune 100 companies and differentiation derives from engagements where we serveover 500 government entities depend on behalf of our clientsConduent every day to manage end-usertheir business processes and essential interactions across a wide-range of domains. Examples include payments, collections, benefit administrationwith their end users. The Company's portfolio includes industry-focused solutions in attractive growth markets such as healthcare and end-user engagementtransportation, as well as solutions that serve multiple industries such as transaction processing, customer care, human resource solutions and payment services.
We create value for our clients through more efficient service delivery combined with a personalized and seamless experience for the end-user. We apply our expertise, technology and innovation to continually modernize our offerings for improved customer and constituent satisfaction and loyalty, increase process efficiency and respond rapidly to changing market dynamics. Our strategy is to drive portfolio focus, operational discipline, sales and delivery excellence and innovation, complemented by tightly aligned investments. Our differentiated services and solutions improve experiences for millions of people every day. Conduent’s solutions deliver exceptional outcomes for its clients, including $16 billion in medical bill savings, $11 billion in child support payments processed more efficiently, up to 40% efficiency increase in HR operations, and up to 40% improvement in processing costs, while driving higher end-user satisfaction.
Headquartered in Florham Park, New Jersey, we have a team of approximately 67,00068,000 people as of March 31,September 30, 2019, servicing customers from service centers in 23 countries.
Financial Review of Operations
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended September 30, | | | | 2019 vs. 2018 | | |
($ in millions) | | 2019 | | 2018 | | $ Change | | % Change |
Revenue | | $ | 1,098 | | | $ | 1,304 | | | $ | (206) | | | (16) | % |
| | | | | | | | |
Operating Costs and Expenses | | | | | | | | | | |
Cost of services (excluding depreciation and amortization) | | 859 | | | 1,005 | | | (146) | | | (15) | % |
Selling, general and administrative (excluding depreciation and amortization) | | 112 | | | 139 | | | (27) | | | (19) | % |
Research and development (excluding depreciation and amortization) | | 1 | | | 2 | | | (1) | | | (50) | % |
Depreciation and amortization | | 115 | | | 113 | | | 2 | | | 2 | % |
Restructuring and related costs | | 8 | | | 31 | | | (23) | | | (74) | % |
Interest expense | | 20 | | | 22 | | | (2) | | | (9) | % |
(Gain) loss on extinguishment of debt | | — | | | 108 | | | (108) | | | (100) | % |
(Gain) loss on divestitures and transaction costs | | 3 | | | 54 | | | (51) | | | (94) | % |
Litigation costs (recoveries), net | | 2 | | | 78 | | | (76) | | | (97) | % |
Other (income) expenses, net | | (8) | | | 4 | | | (12) | | | | |
Total Operating Costs and Expenses | | 1,112 | | | 1,556 | | | (444) | | | |
| | | | | | | | |
Income (Loss) Before Income Taxes | | (14) | | | (252) | | | 238 | | | |
Income tax expense (benefit) | | 2 | | | (15) | | | 17 | | | |
Net Income (Loss) | | $ | (16) | | | $ | (237) | | | $ | 221 | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Nine Months Ended September 30, | | | | 2019 vs. 2018 | | |
($ in millions) | | 2019 | | 2018 | | $ Change | | % Change |
Revenue | | $ | 3,368 | | | $ | 4,111 | | | $ | (743) | | | (18) | % |
| | | | | | | | |
Operating Costs and Expenses | | | | | | | | | | |
Cost of services (excluding depreciation and amortization) | | 2,644 | | | 3,193 | | | (549) | | | (17) | % |
Selling, general and administrative (excluding depreciation and amortization) | | 360 | | | 427 | | | (67) | | | (16) | % |
Research and development (excluding depreciation and amortization) | | 6 | | | 7 | | | (1) | | | (14) | % |
Depreciation and amortization | | 342 | | | 345 | | | (3) | | | (1) | % |
Restructuring and related costs | | 50 | | | 68 | | | (18) | | | (26) | % |
Interest expense | | 60 | | | 92 | | | (32) | | | (35) | % |
(Gain) loss on extinguishment of debt | | — | | | 108 | | | (108) | | | (100) | % |
Goodwill impairment | | 1,351 | | | — | | | 1,351 | | | | |
(Gain) loss on divestitures and transaction costs | | 19 | | | 9 | | | 10 | | | 111 | % |
Litigation costs (recoveries), net | | 15 | | | 113 | | | (98) | | | (87) | % |
Other (income) expenses, net | | (8) | | | 1 | | | (9) | | | | |
Total Operating Costs and Expenses | | 4,839 | | | 4,363 | | | 476 | | | |
| | | | | | | | |
Income (Loss) Before Income Taxes | | (1,471) | | | (252) | | | (1,219) | | | |
Income tax expense (benefit) | | (118) | | | 24 | | | (142) | | | |
Net Income (Loss) | | $ | (1,353) | | | $ | (276) | | | $ | (1,077) | | | |
|
| | | | | | | | | | | | | | | |
| | Three Months Ended March 31, | | 2019 vs. 2018 |
($ in millions) | | 2019 | | 2018 | | $ Change | | % Change |
Revenue | | $ | 1,158 |
| | $ | 1,420 |
| | $ | (262 | ) | | (18 | )% |
| | | | | | | | |
Operating Costs and Expenses | | | | | | | | |
Cost of Services (excluding depreciation and amortization) | | 906 |
| | 1,115 |
| | (209 | ) | | (19 | )% |
Selling, general and administrative (excluding depreciation and amortization) | | 127 |
| | 143 |
| | (16 | ) | | (11 | )% |
Research and development (excluding depreciation and amortization) | | 3 |
| | 2 |
| | 1 |
| | 50 | % |
Depreciation and amortization | | 115 |
| | 116 |
| | (1 | ) | | (1 | )% |
Restructuring and related costs | | 16 |
| | 20 |
| | (4 | ) | | (20 | )% |
Interest expense | | 20 |
| | 33 |
| | (13 | ) | | (39 | )% |
Goodwill impairment | | 284 |
| | — |
| | 284 |
| | — | % |
(Gain) loss on divestitures and transaction costs | | 14 |
| | 15 |
| | (1 | ) | | (7 | )% |
Litigation costs (recoveries), net | | 12 |
| | 31 |
| | (19 | ) | | (61 | )% |
Other (income) expenses, net | | (1 | ) | | (1 | ) | | — |
| | — | % |
Total Operating Costs and Expenses | | 1,496 |
| | 1,474 |
| | 22 |
| |
|
| | | | | | | | |
Income (Loss) Before Income Taxes | | (338 | ) | | (54 | ) | | (284 | ) | |
|
Income tax expense (benefit) | | (30 | ) | | (4 | ) | | (26 | ) | |
|
|
Income (Loss) From Continuing Operations | | $ | (308 | ) | | $ | (50 | ) | | $ | (258 | ) | |
|
Revenue
Revenue for the three and nine months ended March 31,September 30, 2019 decreased, compared to the prior period,year periods, primarily due to the impact from divestitures completed in 2018 and 2019, strategic decisions by management as part of our portfolio rationalization, including exiting certain unprofitable contracts,pricing pressure, contract losses and currency fluctuations. Partially offsetting these declines were increases from the ramp of new business.
Cost of Services (excluding depreciation and amortization)
Cost of services for the three and nine months ended March 31,September 30, 2019 decreased, compared to the prior period,year periods, mainly driven by divestitures completed in 2018 and 2019, reductions in real estate, information technology and labor costs from our strategic transformation initiatives, lost business, strategic contract actions taken by management as part of portfolio management and lower volumes and divestitures completed in 2018 and 2019.volumes.
Selling, General and Administrative (SG&A) (excluding depreciation and amortization)
Lower SG&A for the three and nine months ended March 31,September 30, 2019, compared to the prior period,year periods, was reflective of the impact of our strategic transformation initiatives, primarily due to reductions in labor costs, as well as the reductionincluding reductions in 401(K)401(k) costs, other variable compensation costs, sub-contracting and negotiated IT contract costs. As a result of the Company suspending its 401(K) match for U.S. employees, except hourly employees, there was a $3 million reduction in expense for the three months ended March 31, 2019.
Depreciation and Amortization
Depreciation and amortization for the three months ended March 31,September 30, 2019 increased, compared to the prior year period, primarily due to the HSP acquisition and increased capitalized software amortization for new projects placed in service.
Depreciation and amortization for the nine months ended September 30, 2019 decreased, compared to the prior year period, primarily due to the divestitures in 2018.2018, partially offset by the HSP acquisition and increased capitalized software amortization for new projects placed in service. Refer to Note 6 – Business Acquisition to the Condensed Consolidated Financial Statements for additional information regarding the HSP acquisition.
Restructuring and Related Costs
Restructuring and related costs for the three months ended March 31,September 30, 2019 include $3$1 million of severance costs due to headcount reductions of approximately 200 employees worldwide, $9 million of costs related to data center migration and $4$7 million of lease cancellation and other costs as part of our effort to consolidate our real estate footprint.
Restructuring and related costs for the threenine months ended March 31, 2018September 30, 2019 include $14$17 million of severance costs due to headcount reductions worldwide, $18 million of approximately 700 employees worldwide and $5costs related to data center migration, $13 million of lease cancellation and other costs as part of our effort to consolidate our real estate footprint, and $1$2 million of strategic transformation costs.
Restructuring and related costs for the three months ended September 30, 2018 include $11 million of severance costs due to headcount reductions worldwide and $21 million of lease cancellation and other costs as part of our effort to consolidate our real estate footprint.
Restructuring and related costs for the nine months ended September 30, 2018 include $30 million of severance costs due to headcount reductions worldwide and $38 million of lease cancellation and other costs as part of our effort to consolidate our real estate footprint.
Management continues to evaluate the Company's business, and in the future, there may be additional provisions for new plan initiatives and/or changes in previously recorded estimates as payments are made, or actions are completed.
Refer to Note 7 – Restructuring Programs and Related Costs to the Condensed Consolidated Financial Statements for additional information regarding our restructuring programs.
Interest Expense
Interest expense represents interest on long-term debtsdebt and the amortization of debt issuance costs. DecreaseDecreases in Interest expense for the three and nine months ended March 31,September 30, 2019, compared to the prior period, wasyear periods, were driven primarily by lower average debt balances and repricing as a result ofresulting mostly from the tender offer in 2018.2018 and repricing. Refer to Note 8 – Debt in the Condensed Consolidated Financial Statements for additional information.
Goodwill Impairment
The goodwill impairment for the threenine months ended March 31,September 30, 2019 related to the write-down of the carrying values of the Financial Services & Healthcare (FS&H), Consumer & Industrial (C&I), Europe, Government Services and Transportation segment's carrying value.reporting units. Refer to Note 1817 – Goodwill to the Condensed Consolidated Financial Statements and the MD&A – Critical Accounting Policies – Goodwill for additional information regarding thisthese impairment charge.
(Gain) Loss on Divestitures and Transaction Costs
The current year periodthree months ended September 30, 2019, was related to a loss on sale of assets and transaction costs. The nine months ended September 30, 2019, consists of $5 million of changes in estimates related to losses on divestitures, $2 million related to a loss on sale of assets and $9$12 million of transaction and related costs, $4 million of which relates to costs to remediate Payment Card Industry Data Security Standards compliance issues related to the sale of select standalone customer care contracts to Skyview Capital LLC.
Litigation Costs (Recoveries), Net
Net litigation costs for the threenine months ended March 31,September 30, 2019, consistsconsist primarily of the recognition of the $13 million expense related todiscount on the fair value of the Texas litigation whereasliability established in 2018 due to the acceleration of the settlement in 2019. The prior year period expense wasexpenses were primarily due to the increases in reserves for the Texas litigation and establishment of a reservereserves for certainthe Cognizant terminated contracts that were subject to litigation in 2018.contracts.
Refer to Note 13 – Contingencies and Litigation to the Condensed Consolidated Financial Statements for additional information.
Income Taxes
The effective tax rate for the three months ended March 31,September 30, 2019 was 8.9%(14.3)%, compared with 7.4%to 6.0% for the three months ended March 31,September 30, 2018. The March 31,September 30, 2019 rate was lower than the U.S. statutory rate of 21%, primarily due to pre-tax loss and tax from the geographic mix of income and the inclusion of Global Intangible Low Tax Income (GILTI). The effective tax rate for the three months ended September 30, 2018 was lower than the U.S. statutory tax rate of 21%, primarily due to tax impacts from the divestitures.
Excluding the impact of the divestitures, amortization and restructuring, the normalized effective tax rate for the three months ended September 30, 2019 was 28.8%. The normalized effective tax rate of 25.6% for the three months ended September 30, 2018, was predominantly impacted by the exclusion of the divestitures, the Texas litigation reserve, the loss on extinguishment of debt, amortization of intangible assets, restructuring and divestiture related costs.
The effective tax rate for the nine months ended September 30, 2019 was 8.0%, compared to (9.5)% for the nine months ended September 30, 2018. The September 30, 2019 rate was lower than the U.S. statutory rate of 21%, primarily due to the goodwill impairment charge being partially non-deductible for tax and the geographic mix of income, partially offset by theU.S. federal tax benefitcredits and tax benefits recognized on the sale of a portfolio of select standalone customer care contracts to Skyview Capital LLC.
The effective taxSeptember 30, 2018 rate for the three months ended March 31, 2018 was lower than the U.S. statutory tax rate of 21%, primarily due to pre-tax loss and tax from the geographic mix of income and the impact of Global Intangible Low Tax Income and Base Erosion Anti-Abuse Tax (BEAT), which reduced thedivestitures, partially offset by U.S. foreign tax benefits on the worldwide loss.credits.
Excluding the impact of the goodwill impairment, divestitures, the Texas litigation reserve, chargesamortization and restructuring, the normalized effective tax rate for the nine months ended September 30, 2019 was 31.3%. The normalized effective tax rate of 23.9% for the nine months ended September 30, 2018, was predominantly impacted by the exclusion of divestitures, the Texas litigation reserve, the loss on extinguishment of debt, amortization of intangible assets, restructuring and divestiture related costs, the normalized effective tax rate for the three months ended March 31, 2019 was 34.7%. The normalized effective tax rate of 34.7% for the three months ended March 31, 2018, was predominantly impacted by the exclusion of charges for amortization of intangible assets, restructuring and divestiture related costs and the impact of BEAT.costs.
The Company believes it is reasonably possible that unrecognized tax benefits of approximately $20$13 million will reverse within 12 months due to an anticipated audit settlement.
Operations Review of Segment Revenue and Profit
Our financial performance is based on Segment Profit / (Loss) and Segment Adjusted EBITDA for the following three segments:
•Commercial Industries,
| |
• | Government Services, and
|
Transportation.
•Government Services, and
•Transportation.
Other includes our divestitures and our Student Loan business, which the Company exited in the third quarter of 2018.
We are modernizing a significant portion of our information technology infrastructure with new systems and processes and consolidating our data centers as part of our transformation initiatives. We expect that these changes will provide greater strategic and operational flexibility and efficiency and better control of our systems and processes. Based on our continuing review of our cybersecurity, we are making additional investments to enhance our cybersecurity protection. There is a risk, however, that our modernization efforts and data center consolidations could materially and adversely disrupt our operations. See Part I, Item 1A – Risk Factors of our 2018 Annual Report on Form 10-K for the year ended December 31, 2018 for additional information.
RevenuesResults of financial performance by segment were:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended September 30, | | | | | | | | | | | | |
(in millions) | | Commercial Industries | | Government Services | | Transportation | | Other | | | | Shared IT / Infrastructure & Corporate Costs | | Total |
2019 | | | | | | | | Divestitures | | Other | | | | |
Revenue | | $ | 577 | | | $ | 320 | | | $ | 201 | | | $ | — | | | $ | — | | | $ | — | | | $ | 1,098 | |
Segment profit (loss) | | $ | 108 | | | $ | 100 | | | $ | 38 | | | $ | — | | | $ | — | | | $ | (174) | | | $ | 72 | |
Segment depreciation and amortization | | $ | 25 | | | $ | 6 | | | $ | 9 | | | $ | — | | | $ | — | | | $ | 15 | | | $ | 55 | |
Adjusted EBITDA | | $ | 133 | | | $ | 106 | | | $ | 47 | | | $ | — | | | $ | — | | | $ | (159) | | | $ | 127 | |
| | | | | | | | | | | | | | |
% of Total Revenue | | 52.6 | % | | 29.1 | % | | 18.3 | % | | — | % | | — | % | | — | % | | 100.0 | % |
Adjusted EBITDA Margin | | 23.1 | % | | 33.1 | % | | 23.4 | % | | — | % | | — | % | | — | % | | 11.6 | % |
| | | | | | | | | | | | | | |
2018 | | | | | | | | | | | | | | |
Revenue | | $ | 620 | | | $ | 338 | | | $ | 184 | | | $ | 162 | | | $ | — | | | $ | — | | | $ | 1,304 | |
Segment profit (loss) | | $ | 128 | | | $ | 106 | | | $ | 30 | | | $ | 15 | | | $ | (6) | | | $ | (168) | | | $ | 105 | |
Segment depreciation and amortization | | $ | 22 | | | $ | 7 | | | $ | 9 | | | $ | — | | | $ | 1 | | | $ | 14 | | | $ | 53 | |
Adjusted EBITDA | | $ | 150 | | | $ | 112 | | | $ | 39 | | | $ | 15 | | | $ | (5) | | | $ | (154) | | | $ | 157 | |
| | | | | | | | | | | | | | |
% of Total Revenue | | 47.6 | % | | 25.9 | % | | 14.1 | % | | 12.4 | % | | — | % | | — | % | | 100.0 | % |
Adjusted EBITDA Margin | | 24.2 | % | | 33.1 | % | | 21.2 | % | | 9.3 | % | | — | % | | — | % | | 12.0 | % |
| | | | Three Months Ended March 31, | | Nine Months Ended September 30, | |
(in millions) | | Commercial Industries | | Government Services | | Transportation | | Other | | Shared IT / Infrastructure & Corporate Costs | | Total | (in millions) | | Commercial Industries | | Government Services | | Transportation | | Other | | | Shared IT / Infrastructure & Corporate Costs | | Total |
Three Months Ended March 31, 2019 | | | | | | | | Divestitures | | Other | | | | | |
2019 | | 2019 | | | | | | | | Divestitures | | Other | | | | |
Revenue | | $ | 612 |
| | $ | 325 |
| | $ | 184 |
| | $ | 36 |
| | $ | 1 |
| | $ | — |
| | $ | 1,158 |
| Revenue | | $ | 1,781 | | | $ | 971 | | | $ | 579 | | | $ | 36 | | | $ | 1 | | | $ | — | | | $ | 3,368 | |
Segment profit (loss) | | $ | 113 |
| | $ | 86 |
| | $ | 20 |
| | $ | 1 |
| | $ | — |
| | $ | (151 | ) | | $ | 69 |
| Segment profit (loss) | | $ | 329 | | | $ | 289 | | | $ | 89 | | | $ | 1 | | | $ | — | | | $ | (508) | | | $ | 200 | |
Segment depreciation and amortization | | $ | 22 |
| | $ | 9 |
| | $ | 9 |
| | $ | — |
| | $ | — |
| | $ | 14 |
| | $ | 54 |
| Segment depreciation and amortization | | $ | 68 | | | $ | 21 | | | $ | 26 | | | $ | — | | | $ | — | | | $ | 45 | | | $ | 160 | |
Adjusted EBITDA | | $ | 135 |
| | $ | 95 |
| | $ | 29 |
| | $ | 1 |
| | $ | — |
| | $ | (137 | ) | | $ | 123 |
| Adjusted EBITDA | | $ | 397 | | | $ | 310 | | | $ | 119 | | | $ | 1 | | | $ | — | | | $ | (463) | | | $ | 364 | |
| | | | | | | | | | | | | | | |
% of Total Revenue | | 52.8 | % | | 28.1 | % | | 15.9 | % | | 3.1 | % | | 0.1 | % | | — | % | | 100.0 | % | % of Total Revenue | | 52.9 | % | | 28.8 | % | | 17.2 | % | | 1.1 | % | | — | % | | — | % | | 100.0 | % |
Adjusted EBITDA Margin | | 22.1 | % | | 29.2 | % | | 15.8 | % | | 2.8 | % | | — | % | | — | % | | 10.6 | % | Adjusted EBITDA Margin | | 22.3 | % | | 31.9 | % | | 20.6 | % | | 2.8 | % | | — | % | | — | % | | 10.8 | % |
| | | | | | | | | | | | | | | |
Three Months Ended March 31, 2018 | | | | | | | | | | | | | | | |
2018 | | 2018 | |
Revenue | | $ | 654 |
| | $ | 335 |
| | $ | 176 |
| | $ | 248 |
| | $ | 7 |
| | $ | — |
| | $ | 1,420 |
| Revenue | | $ | 1,900 | | | $ | 1,014 | | | $ | 540 | | | $ | 648 | | | $ | 9 | | | $ | — | | | $ | 4,111 | |
Segment profit (loss) | | $ | 110 |
| | $ | 108 |
| | $ | 27 |
| | $ | 39 |
| | $ | (3 | ) | | $ | (176 | ) | | $ | 105 |
| Segment profit (loss) | | $ | 358 | | | $ | 314 | | | $ | 82 | | | $ | 95 | | | $ | (13) | | | $ | (516) | | | $ | 320 | |
Segment depreciation and amortization | | $ | 28 |
| | $ | 7 |
| | $ | 8 |
| | $ | 2 |
| | $ | 1 |
| | $ | 10 |
| | $ | 56 |
| Segment depreciation and amortization | | $ | 75 | | | $ | 23 | | | $ | 27 | | | $ | 4 | | | $ | 3 | | | $ | 34 | | | $ | 166 | |
Adjusted EBITDA | | $ | 138 |
| | $ | 115 |
| | $ | 35 |
| | $ | 41 |
| | $ | (2 | ) | | $ | (166 | ) | | $ | 161 |
| Adjusted EBITDA | | $ | 433 | | | $ | 335 | | | $ | 109 | | | $ | 99 | | | $ | (10) | | | $ | (482) | | | $ | 484 | |
| | | | | | | | | | | | | | | |
% of Total Revenue | | 46.1 | % | | 23.6 | % | | 12.4 | % | | 17.5 | % | | 0.4 | % | | — | % | | 100.0 | % | % of Total Revenue | | 46.2 | % | | 24.7 | % | | 13.1 | % | | 15.8 | % | | 0.2 | % | | — | % | | 100.0 | % |
Adjusted EBITDA Margin | | 21.1 | % | | 34.3 | % | | 19.9 | % | | 16.5 | % | | (28.6 | )% | | — | % | | 11.3 | % | Adjusted EBITDA Margin | | 22.8 | % | | 33.0 | % | | 20.2 | % | | 15.3 | % | | (111.1) | % | | — | % | | 11.8 | % |
Commercial Industries Segment
Revenue
Commercial Industries revenue for the three months ended March 31,September 30, 2019 decreased, compared to the prior year period, primarily driven by strategic contract actions and contract losses and price pressure, partially offset by revenue from new contracts.
Commercial Industries revenue for the nine months ended September 30, 2019 decreased, compared to the prior year period, primarily driven by contract losses, strategic exits and volume and price pressure, partially offset by revenue from new contracts.
Segment Profit and Adjusted EBITDA
IncreaseDecreases in the Commercial Industries segment profit and adjusted EBITDA margin for the three months ended March 31,September 30, 2019, compared to the prior year period, waswere mainly driven by overall revenue declines.
Decreases in the Commercial Industries segment profit and adjusted EBITDA margin for the nine months ended September 30, 2019, compared to the prior year period, were mainly driven by overall revenue declines, partially offset by reductions in IT, real estate information technology and labor costs from our strategic transformation initiatives and from increases in new business, partially offset by overall revenue decline from lost business, volumes and price declines.
initiatives.
Government Services Segment
Revenue
Government Services revenue for the three and nine months ended March 31,September 30, 2019, decreased compared to the prior period,year periods, primarily driven by contract losses and pricing and scope changes associated with a large renewal. These declines were partially offset by ramp of new business.
Segment Profit and Adjusted EBITDA
Decrease in the Government Services segment profit and adjusted EBITDA margin for the three and nine months ended March 31,September 30, 2019, compared to the prior period, wasyear periods, were mainly driven by lost business, increased IT spend and price declines as well as higher investments in technology platforms,lower revenue, partially offset by reductions in real estatelower IT and labor costs from our strategic transformation initiatives and contract remediation.
Transportation Segment
Revenue
Transportation revenue for the three and nine months ended March 31,September 30, 2019 increased, compared to the prior period,year periods, primarily driven by ramp of new business and volume increases, partially offset by contract losses and service level penalties.client losses.
Segment Profit and Adjusted EBITDA
Transportation segment profit and adjusted EBITDA margin for the three and nine months ended March 31,September 30, 2019 decreased,increased, compared to the prior period,year periods, mainly driven by volume declines, service level penaltiesincreased revenue and increasedreduced IT platform spend partially offset byas well as reductions in real estate and labor costs from our strategic transformation initiatives.
Other
Revenue
Other revenue for the three and nine months ended March 31,September 30, 2019 decreased, compared to the prior period,year periods, driven mainly by the divestitures completed in 2018 and 2019 and the run-off of our Student Loan Services business.
Segment Profit (Loss) and Adjusted EBITDA
Decrease in Other segment profit and adjusted EBITDA for the three and nine months ended March 31,September 30, 2019, compared to the prior period,year periods, were primarily due to divestitures completed in 2018 and 2019 and the run-off of our Student Loan Services business.
Shared IT / Infrastructure & Corporate Costs
Improvements in Shared IT/Infrastructure and Corporate costs for the three months ended March 31,September 30, 2019 increased, compared to the prior year period, wereperiod. This was primarily driven by an increase in shared IT, partially offset by reduced corporate overhead.
Shared IT/Infrastructure and Corporate costs as a result of reductions in real estate, information technology and labor costs from our strategic transformation initiatives as well as a reduction in negotiated IT contract costs.for the nine months ended September 30, 2019 decreased, compared to the prior year period. This was primarily driven by corporate cost reductions.
Metrics
Signings
Signings are defined as estimated future revenues from contracts signed during the period, including renewals of existing contracts. Total Contract Value (TCV) is the estimated total contractual revenue related to signed contracts. The amounts in the following table exclude divestitures.
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| | Three Months Ended September 30, | | | | 2019 vs. 2018 | | |
($ in millions) | | 2019 | | 2018 | | $ Change | | % Change |
New business TCV | | $ | 234 | | | $ | 264 | | | $ | (30) | | | (11) | % |
Renewals TCV | | 512 | | | 474 | | | 38 | | | 8 | % |
Total Signings | | $ | 746 | | | $ | 738 | | | $ | 8 | | | 1 | % |
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Recurring revenue signings(1) | | $ | 71 | | | $ | 65 | | | $ | 6 | | | 9 | % |
Non-recurring revenue signings(2) | | $ | 43 | | | $ | 63 | | | $ | (20) | | | (32) | % |
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| | Three Months Ended March 31, | | 2019 vs. 2018 |
($ in millions) | | 2019 | | 2018 | | $ Change | | % Change |
New business TCV | | $ | 225 |
| | $ | 367 |
| | $ | (142 | ) | | (39 | )% |
Renewals TCV | | 727 |
| | 926 |
| | (199 | ) | | (21 | )% |
Total Signings | | $ | 952 |
| | $ | 1,293 |
| | $ | (341 | ) | | (26 | )% |
| | | | | | | | |
Recurring revenue signings(1) | | $ | 52 |
| | $ | 81 |
| | $ | (29 | ) | | (36 | )% |
Non-recurring revenue signings(2) | | $ | 32 |
| | $ | 53 |
| | $ | (21 | ) | | (40 | )% |
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| | Nine Months Ended September 30, | | | | 2019 vs. 2018 | | |
($ in millions) | | 2019 | | 2018 | | $ Change | | % Change |
New business TCV | | $ | 787 | | | $ | 977 | | | $ | (190) | | | (19) | % |
Renewals TCV | | 1,724 | | | 2,941 | | | (1,217) | | | (41) | % |
Total Signings | | $ | 2,511 | | | $ | 3,918 | | | $ | (1,407) | | | (36) | % |
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Recurring revenue signings(1) | | $ | 207 | | | $ | 225 | | | $ | (18) | | | (8) | % |
Non-recurring revenue signings(2) | | $ | 124 | | | $ | 177 | | | $ | (53) | | | (30) | % |
___________
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(1) | Recurring revenue signings are for new business contracts longer than one year. |
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(2) | Non-recurring revenue signings are for contracts shorter than one year. |
(1)Recurring revenue signings are current period revenue for new business contracts longer than one year.
(2)Non-recurring revenue signings are for contracts shorter than one year.
Signings for the three months ended March 31,September 30, 2019 increased, compared to the prior year period, mainly due increased renewals, partially offset by decreased new business due to sales headcount challenges and a continued focus on strategic wins with acceptable margins.
Signings for the nine months ended September 30, 2019 decreased, compared to the prior year period, mainly due to sales headcount challenges and a continued focus on strategic wins with acceptable margins, longer lead times and delays in signings.
Renewal Rate
Renewal rate is defined as the annual recurring revenue (ARR) on contracts that are renewed during the period as a percentage of ARR on all contracts for which a renewal decision was made during the period, excluding any contracts that were not renewed and where a strategic action to improve the risk or profitability had been initiated.
Excluding our strategic decision not to renew certain contracts, renewal rates for the three months ended March 31,September 30, 2019 and 2018 were 92%93% and 94%90%, respectively, and for the nine months ended September 30, 2019 and 2018 were 83% and 96%, respectively.
Critical Accounting Policies - Goodwill
As a resultIn the second quarter of the Transportation reporting unit experiencing2019, there were further unanticipated losses of certain customer contracts, lower potential future volumes and lower than expected new customer contracts and higher costs of delivery (all subsequent to FebruaryMay 9, 2019), the growth of this reporting unit decreased resulting in its fair value. This led to actual results being below its carrying value by approximately $284 million.budget and a further downward revision of the long-term forecast across all the Company’s reporting units (FS&H, C&I, Europe, Government Services, and Transportation). As a result,consequence of the Company recordedbusiness performance and the strategy pivot due to changes in management that occurred in the second quarter of 2019, we lowered our sales outlook, average margin expectation for the future years, and increased our weighted average cost of capital.
The table below summarizes key factors (by reporting unit) impacting our revised forecast within the second quarter of 2019 goodwill assessment.
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Key Factors | | FS&H | | C&I | | Europe | | Government Services | | Transportation |
Lower anticipated new business | | X | | X | | X | | X | | X |
Potential higher than anticipated contract losses | | X | | | | X | | X | | X |
Potential volume pressures | | | | X | | X | | | | X |
Strategic pivot | | X | | X | | X | | X | | X |
Based upon the information identified in the second quarter of 2019, we performed an interim goodwill impairment assessment for all our reporting units which resulted in a pre-tax impairment charge of approximately $284 million.
In addition, based on our discounted cash flow and market multiple analysis, we evaluated if the goodwill of the other reporting units were also impaired. The weighted average cost of capital used$1.1 billion for the discounted cash flow analysisthree months ended June 30, 2019. The cumulative impairment charge for the nine months ended September 30, 2019 was between 10% and 13%, depending on the reporting unit. Although, we did not have a goodwill$1.4 billion. There was no impairment identified in the Financial Services & Healthcare (FS&H)third quarter of 2019 for any of our reporting unit, the Consumer & Industrial (C&I) reporting unit or in the Government Services reporting unit, the fair values of each of these reporting units have declined. These reporting units may become impaired if they experience significant customer losses, do not achieve new customer signing projections, or incur higher costs than projected. The goodwill, carrying values and the headroom for FS&H, C&I, Europe and the Government reporting units are as follows:units.
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| | March 31, 2019 |
(amounts in millions) | | Goodwill | | Carrying Value | | Headroom |
Reporting Unit: | | | | | | |
FS&H | | $ | 982 |
| | $ | 1,023 |
| | 26 | % |
C&I | | 389 |
| | 439 |
| | 30 | % |
Europe | | 67 |
| | 90 |
| | 70 | % |
Government services | | 1,376 |
| | 962 |
| | 17 | % |
Transportation | | 357 |
| | 570 |
| | — | % |
In addition, because the fair value of the Transportation unit is equal to the book value of the reporting unit, the Transportation reporting unit goodwill could be further impaired if there are further customer contracts losses and lower expected new customer contracts.
The most significant assumption used in the goodwill analysis relates to the long-term organic growth rates. For example, the EBITDA long-term growth rate for FS&H and C&I reporting units was 3%, and for Government Services was 2.5%. The growth rates are consistent with industry long-term growth rates and contemplate that Conduent will grow, on a long-term basis, at least consistent with its peers. To the extent that Conduent loses a significant contract or multiple significant contracts, such that its growth rates are negatively impacted, its goodwill could be impaired. For example, if Conduent’s EBITDA long-term growth rates were reduced to 1% for all reporting units (except for Europe and Transportation), the fair values of the reporting units would approximate their book values.
Capital Resources and Liquidity
As of March 31,September 30, 2019, and December 31, 2018, total cash and cash equivalents were $520$228 million and $756 million, respectively. The Company also has a $750 million revolving line of credit for its various cash needs, of which $12$79 million has been utilized for letters of credit.
In MayFebruary 2019 a settlement agreement and release was reached among the Company, entered into the First Amendment to Settlement Agreement and Release with the State of Texas.Texas ("State") and the Texas Department of Health and Human Services, which was amended in May 2019 ("Texas Agreement"). Pursuant to the terms of the AmendedTexas Agreement, the amount paidCompany was required to pay the State by the Conduent Defendants in full settlement$236 million, of the State Action will be paid as follows: (1) $40 million on or before April 15, 2019 (which the Company has already paid); (2) $78 million on or before May 15, 2019 (the “First Payment”); and (3)which $118 million on or beforewas paid in 2019 with a balance of $118 million due in January 15, 2020, (the “Second Payment”). In order to secure the Second Payment, thewhich is fully reserved. The Company will provideprovided bank issued letters of credit to the State in the full amount of $118 million to secure the Second Payment (the “LCs”)payment due in January 2020 which will be released on the State may present for payment to91st day following the issuing banks ifCompany’s payment. The case has been dismissed with prejudice with a full release and discharge of the Conduent Defendants do not make the Second Payment.Company.
As of March 31,September 30, 2019, there were $1.5 billion outstanding borrowings under our Credit Agreement of which $53$50 million was due within one year. Refer to Note 8 – Debt in the Condensed Consolidated Financial Statements for additional debt information.
We expect our operating cash flows combined with cash on hand and financing activities to be sufficient to fund expected operating and anticipated capital and other funding requirements for at least the next twelve months.
Cash Flow Analysis
The following table summarizes our cash flows, as reported in our Condensed Consolidated Statement of Cash Flows in the accompanying Condensed Consolidated Financial Statements:
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| | Nine Months Ended September 30, | | | | |
(in millions) | | 2019 | | 2018 | | Better (Worse) |
Net cash provided by (used in) operating activities | | $ | (216) | | | $ | 30 | | | $ | (246) | |
Net cash provided by (used in) investing activities | | $ | (253) | | | $ | 534 | | | (787) | |
Net cash provided by (used in) financing activities | | $ | (60) | | | $ | (627) | | | 567 | |
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| | Three Months Ended March 31, |
(in millions) | | 2019 | | 2018 | | Better (Worse) |
Net cash provided by (used in) operating activities | | $ | (49 | ) | | $ | (38 | ) | | $ | (11 | ) |
Net cash provided by (used in) investing activities | | (168 | ) | | (39 | ) | | (129 | ) |
Net cash provided by (used in) financing activities | | (22 | ) | | (27 | ) | | 5 |
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Historically the Company generates the majority of its cash from operating activities in the last two quarters of the year, as such the Company expects the second quarter cash flow from operations to also be negative.
Operating activities
Net increase in cash used in operating activities of $(49)$246 million was the result of $20primarily related to $131 million in payments for the Texas and other litigation as well as negative working capital (which was partially offset by unpaidand higher accounts payables for an IT supplier).payable payments of $136 million due to timing.
Investing activities
The increase in cash used in investing activities of $787 million for the threenine months ended March 31,September 30, 2019, compared to the prior year period, was primarily due to the absence of the proceeds from divestitures and assets sales in 2018, acquisition of HSP and increased spending for capital expenditures related to modernizing our information technology infrastructure.infrastructure for both customer-facing and internal functions in 2019.
Financing activities
The decrease in cash used in financing activities for the threenine months ended March 31,September 30, 2019, compared to the prior year period, was related to lower debt payments.
Market Risk Management
We are exposed to market risk from changes in foreign currency exchange rates which could affect operating results, financial position and cash flows. We manage our exposure to these market risks through our regular operating and financing activities and, when appropriate, through the use of derivative financial instruments. We may utilize derivative financial instruments to hedge economic exposures, as well as to reduce earnings and cash flow volatility resulting from shifts in market rates. We also may hedge the cost to fund material non-dollar entities by buying currencies periodically in advance of the funding date. This is accounted for using derivative accounting.
Recent market events have not caused us to materially modify nor change our financial risk management strategies with respect to our exposures to foreign currency risk. Refer to Note 9 – Financial Instruments in the Condensed Consolidated Financial Statements for additional discussion on our financial risk management.
ITEM 3 — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information set forth under the “Market Risk Management” section in Item 2 of this Quarterly Report on Form 10-Q is hereby incorporated by reference in answer to this Item.
ITEM 4 — CONTROLS AND PROCEDURES
(a)Evaluation of Disclosure Controls and Procedures
The Company’s management evaluated, with the participation of our principal executive officer and principal financial officer, or persons performing similar functions, the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended ("Exchange Act"), as of the end of the period covered by this report. Based on this evaluation, our principal executive officer and principal financial officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to ensure that information we are required to disclose in the reports that we file or submit under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms relating to Conduent Incorporated, including our consolidated subsidiaries, and was accumulated and communicated to the Company’s management, including the principal executive officer and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
(b)Changes in Internal Control Over Financial Reporting
Beginning January1,January 1, 2019, we implemented the new lease accounting standard. Although the adoption of this standard did not have a material impact on our Condensed Consolidated Statements of Income (Loss) or Condensed Consolidated Statements of Cash Flows for the threenine months ended March 31,September 30, 2019, we did implement changes to our internal controls related to the implementation of the new lease accounting standard. These changes included performing a comprehensive lease scoping analysis to identify, disaggregate and evaluate each of our lease categories and implementing a new information technology application to calculate ROU assets and lease liabilities values for our leases. There were no other changes in our internal control over financial reporting during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II — OTHER INFORMATION
ITEM 1 — LEGAL PROCEEDINGS
The information set forth under Note 13 – Contingencies and Litigation in the Condensed Consolidated Financial Statements of this Quarterly Report on Form 10-Q is incorporated herein by reference in answer to this Item.
ITEM 1A — RISK FACTORS
Reference is made to the Risk Factors set forth in Part I, Item 1A of our 2018 Annual Report on Form 10-K. There have been no material changes to our risk factors as previously reported in our 2018 Annual Report on Form 10-K.
ITEM 2 — UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
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(a) | Sales of Unregistered Securities during the Quarter ended March 31, 2019 |
(a)Sales of Unregistered Securities during the Quarter ended September 30, 2019
During the quarter ended March 31,September 30, 2019, the Company did not issue any securities in transactions that were not registered under the Securities Act of 1933, as amended.
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(b) | Issuer Purchases of Equity Securities during the Quarter ended March 31, 2019 |
(b)Issuer Purchases of Equity Securities during the Quarter ended September 30, 2019
None.
ITEM 6 — EXHIBITS
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| | Incorporated by reference to Exhibit 3.1 to Registrant's Current Report on Form 8-K dated December 23, 2016. |
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| | Incorporated by reference to Exhibit 3.2 to Registrants Current Report on Form 8-K dated December 23, 2016. |
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| | Incorporated by reference to the Registrant’s Current Report on Form 8-K dated May 6, 2019. (See SEC file Number 001-37817). |
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101.INS | | XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. |
101.CAL | | XBRL Taxonomy Extension Calculation Linkbase. |
101.DEF | | XBRL Taxonomy Extension Definition Linkbase. |
101.LAB | | XBRL Taxonomy Extension Label Linkbase. |
101.PRE | | XBRL Taxonomy Extension Presentation Linkbase. |
101.SCH | | XBRL Taxonomy Extension Schema Linkbase. |
104 | | Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101). |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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CONDUENT INCORPORATED (Registrant) |
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By: | /S/ ALLAN COHEN
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By: | Allan Cohen
/S/ MARIO A. POMPEO |
| Mario A. Pompeo Vice President and Chief Accounting Officer
(Principal Accounting Officer)
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Date: November 6, 2019
Date: May 8, 2019